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Forecasting Euro-area recessions using time-varying binary response models for financial

  • Bellégo, C.
  • Ferrara, L.

Recent macroeconomic evolutions during the years 2008 and 2009 have pointed out the impact of financial markets on economic activity. In this paper, we propose to evaluate the ability of a set of financial variables to forecast recessions in the euro area by using a non-linear binary response model associated with information combination. Especially, we focus on a time-varying probit model whose parameters evolve according to a Markov chain. For various forecast horizons, we provide a readable and leading signal of recession by combining information according to two combining schemes over the sample 1970-2006. First we average recession probabilities and second we linearly combine variables through a dynamic factor model in order to estimate an innovative factor-augmented probit model. Out-of-sample results over the period 2007-2008 show that financial variables would have been helpful in predicting a recession signal as September 2007, that is around six months before the effective start of the 2008-2009 recession in the euro area.

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Paper provided by Banque de France in its series Working papers with number 259.

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Length: 26 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:bfr:banfra:259
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